RISK ASSESSMENT

Moderate rate of growth underpinned by consumption and tourism

Despite levels of household debt that remain in excess of 120% of GDP, the upturn in private consumption will continue, encouraged by falling unemployment, the end of wage freezes, in particular in the public sector, and a steadying in house prices (following a 30% fall since 2010). This will also be boosted by the spending of the three million foreign tourists, amounting to more than three times the local population, visiting the island. Tourism, maritime transport and non-financial corporate services are the island’s three traditional export sectors and are feeling the benefits of the increased competitiveness resulting from the deprecation of the euro and low wage inflation extending the benefits of the decline in wages in recent years. The surplus from these almost covers the trade deficit (18% in 2015) that reflects the very limited diversification in local manufacturing (drugs, cheese and electronics). The likely fall in tourist numbers and spending from the United Kingdom (39% of visitors in 2015) as a result of the depreciation of the pound sterling will probably be largely offset by the increasing geographic diversification of visitors, particularly its increasing popularity with Russian tourists (25% of visitors) which is not expected to change despite the lifting of the restrictions imposed by Russian against Turkey. Despite already high levels of company debt, the upturn in the construction of tourist facilities (marinas, golf courses, ports and theme parks) and offices, the other leading sector, is also expected to continue. Public investment will remain restricted by budget constraints.

A banking sector in midst of lengthy convalescence

Following its accession to the EU in 2004, the Cypriot banking sector swelled to six times GDP. The contraction of the property market at the end of 2008 and the collapse of the Greek economy, in which it was heavily invested, at the beginning of 2010 proved fatal to it, leading to the insolvency of the leading players. Given the government’s inability to carry out the rescue operation, following the deterioration of the public and foreign accounts, under pressure from the European Commission, the ECB and the IMF which made it a condition of any financial assistance, the Cypriot authorities carried out a restructuring of the sector mainly paid for by creditors and depositors. Despite the bankruptcy of one of the biggest banks, the sector, currently highly concentrated, remains very large (3.7 times GDP in June 2016), excluding foreign banks (160%). Thanks to the gradual implementation of the insolvency and foreclosure legislation approved in 2015, the scale of bad debt is being reduced. It does still however account for 48% of bank portfolios (August 2016) and only 40% are covered by provision. Dealing with these has been made extremely complex by the difficulties in estimating the value of the securities used as guarantee, the lack of land registry records for apartments, as well as the slow pace of the transfer by the relevant authorities of title deeds from developers to purchasers. Given this mess, neither households nor developers feel any urgency in repaying their loans. Nevertheless, the increase in deposits recorded since 2015, the growth in new credit and the virtual ending of the use of the liquidity facilities of the Central Bank, are all positive signs in a sector being monitored by the ECB.

High levels of public and foreign debt

The global public deficit has almost disappeared. The primary surplus (i.e. excluding debt interest) and growth should help ease the huge burden of the public debt. Investors, showing their confidence in the improvements, supported a seven year 1 billion euro issue at 3.75% in July 2016. There is a risk, with the reducing influence of the European institutions and the IMF since the end of the assistance program and with the upcoming Presidential election in 2018, that the political class will ease back on its efforts in what is a long-haul struggle. Whilst reforms of the administration (promotion, wage structure, mobility) are underway, reforms in the management of public sector companies, together with privatisations (Cyprus Telecom, Limassol port, electricity), are falling behind. The external debt represents more than 5 times GDP. Almost 70% falls on the private sector, of which 60% correspondents with the commitments of ad hoc structures intended to finance ship-owners and what are in many cases non-resident companies. The purely domestic portion nevertheless still amounts to over 3 times GDP.

A minority government in talks on possible reunification of the island

The legislative elections in May 2016 confirmed the President’s conservative Democratic Rally party (DISY), as the biggest party in Parliament, with 18 seats out of 56. Opposed by the 16 members of the AKEL (communist) party, President Nicos Anastasiades needs to find ad hoc majorities with the 9 centrist members of the Democratic Party (DIKO) and the 5 members of smaller parties, by combining budget balancing with social measures such as the creation of a national health system. Negotiations have also been taking place between the Greek and Turkish Cypriot community governments on the island aimed at ending the partition of the country. This will provide a boost to the economy and, in particular, any future development of offshore gas fields. Any settlement will depend, among others, on the attitude of Turkey, which maintains a military presence in the north of the island.